RBI maintains status quo; repo rate retained at 6 percent, cuts SLR by 50 bps to 19.5%

The Reserve Bank of India (RBI) on Wednesday kept its key lending rate—the repo rate—unchanged at 6 percent but acknowledged that the disruptions from goods and services tax (GST) have worsened the broader economy’s prospects in the short term.

The RBI also cut the statutory liquidity ratio (SLR)—the proportion of deposits banks are required to park in government bonds— by 50 basis points to 19.5 percent from 20 percent currently, a move aimed at unlocking more funds for banks to lend.

The reduced SLR will be effective from October 14.

The status quo on repo rate—the rate at which banks borrow from the RBI—dashed hopes further lowering of borrowing costs for households and the companies ahead of the festival season.

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The RBI also sharply revised the economy’s growth forecasts for 2017-18. The central bank now expects the gross value added (GVA) to grow at 6.7 percent in 2017-18 from 7.3 percent projected earlier.

“The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term,” RBI governor Urjit Patel said.

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This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates.

The government’s central statistics office (CSO) estimates released in August show that GVA grew 5.6 percent in April-June lower than the last year’s 7.6 percent growth during the same quarter.

The six-member monetary policy committee (MPC), headed by RBI governor Urjit Patel, kept one eye firmly on rising the inflation that is perilously inching towards the RBI’s 4 percent threshold level.

The decision to keep the rates unchanged was based on 5:1 majority opinion within the MPC. While Chetan Ghate, Pami Dua, Michael Debabrata Patra, Viral V. Acharya and Patel were in favour of the monetary policy decision, Ravindra H. Dholakia voted for a policy rate reduction of at least 25 basis points.

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The MPC placed the onus firmly on the government to engineer a quick turnaround in the economy that was still smarting under an imperfect GST rollout, marred by complaints about technical glitches on the tech backbone and procedural hassles.

“The following measures could be undertaken to support growth and achieve a faster closure of the output gap: a concerted drive to close the severe infrastructure gap; restarting stalled investment projects, particularly in the public sector; enhancing ease of doing business, including by further simplification of the GST; and ensuring faster rollout of the affordable housing program with time-bound single-window clearances and rationalisation of excessively high stamp duties by states,” the monetary policy statement said.

The Indian consumer is set to feel the pinch of high prices next year, with the MPC forecasting that retail inflation will hover around 4.2-4.6 percent between October-March this year, higher than the previous projection of 4-4.5 percent.

The MPC also maintained a “neutral,” stance, keeping the door ajar for a future rate cut if incoming data were conducive.

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According to the RBI, early indicators show that prices of pulses which had declined significantly in recent months have now begun to stabilise. Also, “some price revisions pending the goods and services tax (GST) implementation have been taking place”. International crude prices, which had started rising from early July, have firmed up further in September.

In August, the MPC had recommended a 25 basis point (0.25 percentage point) cut in the repo rate to 6 percent. Business leaders have been arguing for a repeat action to revive investment, spur spending and aid a turnaround in the broader economy’s growth that has slumped to a 13-quarter low of 5.7 percent in April-June.

The central bank and the MPC, however, made it clear that it stood firmly on the side of inflation control in the growth-inflation trade-off.

India’s retail inflation rate, which is the main price gauge that the RBI tracks, stood at 3.4 percent in August, sharply higher than the previous month’s 2.36 percent.

The retail inflation rate, which tracks shop-end price changes measured by the consumer price index, has more than doubled from 1.5 percent in June 2017 to 3.4 percent in August 2017.

Economic growth, on the other hand, has weakened. India’s real or inflation-adjusted gross domestic product grew 5.7 percent in April-June, the slowest in 13 quarters.

It was sharply lower than last year’s 7.9 percent expansion in the same quarter as also the previous quarter’s 6.1 percent growth, signs that the country was still reeling under the shock of demonetisation and disruption caused ahead of GST’s rollout.

Importantly, the CSO estimates shows that gross value added (GVA) grew 5.6 percent in April-June lower than the last year’s 7.6 percent growth during the same quarter.

The MPC also maintained a “neutral,” stance, meaning a chance of rate cut in the near future would be data-driven.

India’s factory output grew at a tepid 1.2 percent in July as compared with a fall of 0.1 percent in June, although there were signs that production would have risen in August and September as companies have begun restocking and building fresh inventories after clearing up the stockpile in the previous month ahead of Goods and Services Tax’s roll out from July 1.

The manufacturing sector, which accounts for more than three-fourth of the entire index, continued to crawl at 0.1 percent growth in July, compared with (-) 0.4 percent in June and 5.3 percent in the same period last year.

“It is imperative to reinvigorate investment activity which, in turn, would revive the demand for bank credit by the industry as existing capacities get utilized and the requirements of new capacity open up to be financed,” the monetary policy statement said.

Recapitalising public sector banks adequately will ensure that credit flows to the productive sectors are not impeded and growth impulses not restrained.

The cut in SLR is aimed at giving more funds for banks to lend to industry and consumers. Greater funds would bring down banks’ costs reducing their dependence on high fixed deposit returns to garner deposits. Lower costs, in turn, will goad them to cut interest rates they charge from home, consumer goods and corporate loan borrowers.

Experts, however, were not quite sure to what extent this cycle will play out given that banks, flush with excess liquidity, are currently parking more than the required 20 percent of their deposits in government bonds.